MAPS Hotel and Resorts One LLC (the Buyer) agreed to purchase 15 hotel properties from AB Stable VIII LLC (the Seller) for US$5.8 billion in September 2019 pursuant to a Sale and Purchase Agreement (the SPA). For a number of reasons, closing was delayed and did not occur before the onset of the COVID-19 pandemic and associated lockdowns, which had a significant effect on the hotel industry. The Seller responded to the pandemic by “temporarily closing two hotels (one ahead of its normal seasonal closing), operating other hotels at 16 reduced staffing, and pausing all non-essential capital spending,” among other things. The Seller sought the Buyer’s consent while maintaining that consent was not required, but did not respond when the Buyer requested additional information in connection with the Seller’s request. The Seller sought to compel the Buyer to close after the Buyer refused to do so. At trial, the Court of Chancery ruled that the Seller had breached the ordinary course covenant and that the Buyer could not be compelled to close (previously covered here).
The Delaware Supreme Court, sitting en banc, affirmed. It found that the Seller’s actions in response to the COVID-19 pandemic, which it termed “drastic,” violated the Seller’s covenant to operate the subject business “only in the ordinary course of business, consistent with past practice in all material respects.” The court held that it did not matter whether the Seller’s response to the pandemic was reasonable, or whether it was consistent with the way other hotel operators were responding to the pandemic, because under the covenant “compliance is measured by its operational history, and not that of the industry in which it operates.” The court also noted that the ordinary course covenant did not contain any reasonableness qualifiers, such as language allowing the Seller to operate in the ordinary course where commercially reasonable to do so. The court concluded that although “Seller could have timely sought the Buyer’s approval before making drastic changes to its hotel operations, approval which could not be unreasonably withheld…[h]aving failed to do so, the Seller breached the Ordinary Course Covenant and excused the Buyer from closing.”
The court also rejected the seller’s argument that the ordinary course covenant should be read to permit pandemic-related changes because the SPA’s “material adverse effect” (MAE) provision allocated all risks associated with the pandemic to the Buyer. The MAE provision included a carve out for “natural disasters and calamities,” which the parties did not dispute covered the pandemic for purposes of the appeal. However, the court held that the SPA “distinguishes between the question of whether the business operated in the ordinary course and whether the business suffered a Material Adverse Effect, and it makes the former irrelevant to the latter.” Specifically, the SPA included a requirement that the Seller attest that no MAE had occurred, “whether or not in the ordinary course of business.” The court also noted that the ordinary course covenant included a materiality qualifier rather than an MAE qualifier, which the court found “shows that the parties intended the provisions to act independently” because an MAE standard is “much higher” and “analytically distinct” from a materiality standard. Finally, the court held that “an ordinary course covenant and MAE provision serve different purposes.” Ordinary course covenants are “included to reassure the Buyer that the target company has not materially changed its business or business practices during the pendency of the transaction,” while an “MAE provision, by contrast, allocates the risk of changes in the target company’s valuation.”
Finally, the court rejected the Seller’s argument that it was not “required to run the business into the ground by continuing to operate in the ordinary course of business,” noting that the Seller should have sought the Buyer’s consent, which could not be unreasonably withheld under the SPA.
